Magazine

Uncle Sam: Up To His Neck In The Risk Pool

June 05, 2005

Few people pay much attention to such arcane issues as government pension guarantees. But when bankrupt UAL Corp.'s (UALQ) United Airlines Inc. recently dumped $6.6 billion in unfunded pension liabilities on the Pension Benefit Guaranty Corp. (PBGC), the obscure federal agency was suddenly front-page news. The reason for all the interest: United's move comes on top of a wave of recent corporate bankruptcies that has left the PBGC $23 billion short of what it needs to cover failed pensions. This raises the unsettling prospect of taxpayers getting stuck with a savings-and-loan-type bailout of the agency, which backstops traditional pension plans for 44 million workers and retirees who would otherwise take a bigger hit.

It turns out that the PBGC is just one pool in a vast sea of risks that Washington bears. Over the years, Congress has created one program after another to insure individuals and businesses against a panoply of hazards, from natural disasters to bank failures to nuclear reactor meltdowns. Surprisingly, the federal government doesn't tote up the potential price of all these promises. But collectively they add up to an astounding $6 trillion-plus in possible claims, according to the Center on Federal Financial Institutions (COFFI), a Washington think tank. Says Kenneth A. Froot, a Harvard Business School business administration professor: "The federal government has assumed risks all over the map, and I don't think anybody has good numbers on the exposure."

No one is suggesting an Armageddon scenario in which all these trillions come due at once. But policymakers' failure to get a grip on the mountain of insurance they're piling up could be costly, since it's widely assumed that taxpayers would have to bail out a government insurer that gets swamped with claims. In addition, it's far from certain that Congress is socking away enough money to cover payouts that could be owed under more likely outcomes. For public policy reasons or because the risks are hard to predict, some federal insurance systems don't pay their own way. For example, the government charges insurers nothing at all for reinsurance against another major terrorist attack like September 11.

Federal budgeting math exacerbates the problem, since it often masks the true cost of insurance to taxpayers. The national budget shows annual cash flows from premiums and payouts on claims, with no money set aside for future liabilities. That makes it difficult to see the total long-term obligations Congress has assumed. "The government often gives away free or cheap insurance and acts as if there is no cost until we cut the check," says COFFI President Douglas J. Elliott.

The PBGC is the most glaring example of this buy-now, pay-later approach. Even today, the agency actually looks like a profit center in the federal budget. Because the premiums employers pay to the PBGC -- plus its investment income -- exceed its payouts to cover failed pensions, the agency shows up as having contributed a total of $12 billion to federal coffers since 1982. In recent years, though, its long-term pension liabilities have soared with all the corporate bankruptcies. Some analysts even believe the long-term deficit is much larger than the PBGC's own $23 billion appraisal. Using a broader pricing methodology, congressional number-crunchers figure the agency faces a shortfall of more than $120 billion over the next decade.

MURKY TOTALS

A lot of the problem stems from the lack of budget clarity. Because Washington doesn't have to put money aside for the PBGC's future liabilities, it's all too easy for Congress to expand its insurance commitments. That's what happened last year when airlines and steel producers got a big break on pension fund contributions, increasing the cost to the PBGC if it eventually has to take over any of those companies' plans. Now, Congress is mulling tighter pension-funding rules and higher premiums, but lawmakers might have acted sooner if the budget had reflected economic reality. "When [lawmakers] are asked to make decisions about additional insurance, they're not told what they may be putting the government on the hook for in the future," says Susan J. Irving, director of federal budget analysis at the Government Accountability Office (GAO).

Congress, in 1990, did shift to a more transparent budgeting method for most federal loan programs, such as those for housing and to students. But attempts to use a pay-as-you-go system for federal insurance fizzled because some risks are tough to calculate and because it would draw attention to programs' potential high costs.

The real question is whether Congress should put aside funds to cover all the various insurance risks. Take terrorism. In 2002, Congress required insurance companies to resume offering terrorism coverage to companies, a business many had pulled out of after the 2001 terrorist attacks. In return, lawmakers pledged to bear the cost of most large claims, up to $100 billion. The program expires at the end of the year, so Congress now is considering whether and how to renew it. Many economists think it should require insurers to pay annual premiums, just as employers do with the PBGC. Not charging premiums "is like me not paying State Farm for auto insurance because I don't have any claims yet," says J. Robert Hunter, director of insurance at the Consumer Federation of America.

Even if that happens, taxpayers could still face a huge liability. After all, insured losses caused by the September 11 attacks totaled some $32 billion, about a third of which Uncle Sam stepped in to pay. While it would be difficult to calculate how much money Congress should budget each year to cover all the potential losses in a future attack, it's not impossible, experts say. Models developed by Insurance Services Office Inc., a purveyor of risk products and services, show Washington should be setting aside about $1.4 billion a year, Hunter says.

Lawmakers also are weighing changes in coverage and funding rules for the Federal Deposit Insurance Corp. (FDIC), which insures bank deposits up to $100,000. It's funded by premiums banks pay on the deposits they hold. But some industry critics argue that Congress set the premiums too low. Most banks have paid nothing at all to the FDIC since 1997, because the $47 billion in reserves it has built up exceed the legally required ratio. What would happen, though, if the current housing bubble burst? Bank failures could quickly deplete the reserves, predicts George G. Pennacchi, a finance professor at the University of Illinois at Urbana-Champaign. If that occurred, banks would be required to kick in more, right when they're racking up losses. "And you can be sure the healthy banks would say: 'We shouldn't be penalized for the failures of our poorly run brethren,"' says Pennacchi.

Understandably, Congress shrinks from raising costs, either as premiums to employers or as another item in Uncle Sam's budget. But it may need to reconsider as the true burden of federal insurance promises comes to light.